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201-896-4100 info@sh-law.comFirm Insights
Author: Scarinci Hollenbeck, LLC
Date: November 11, 2021
The Firm
201-896-4100 info@sh-law.comThe Securities and Exchange Commission (SEC) recently published its much-anticipated report on the January 2021 GameStop (GameStop or GME) stock trading frenzy and the larger meme-stock phenomenon. The report, entitled Staff Report on Equity and Options Market Structure Conditions in Early 2021, highlighted areas that need further examination but stopped short of calling for specific regulatory changes.
“The extreme volatility in meme stocks in January 2021 tested the capacity and resiliency of our securities markets in a way that few could have anticipated,” the report stated. “At the same time, the trading in meme stocks during this time highlighted an important feature of United States securities markets in the 21st century: broad participation.” The report concludes: “These events present an opportunity to reflect on the market structure and regulatory framework and identify additional areas for potential study and further consideration in the interests of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.”
The SEC report addresses the recent phenomenon known as “meme stocks.” The term refers to stocks that gain sudden popularity on the internet, largely through social media and websites like Reddit. When stocks go “viral,” it generally causes prices to skyrocket and generates unusually high trading volume. In many cases, a meme stock’s increasing value reflects the social media buzz rather than the company’s performance, which can lead to a dramatic drop in stock price as it becomes overvalued.
As highlighted by the SEC, GameStop experienced a confluence of all of the factors that impacted the meme stocks in early 2021, including: large price moves; large volume changes; large short interest; frequent Reddit mentions; and significant coverage in the mainstream media. As we detailed in prior articles, everyday investors united on social media to send GameStop Corp’s stock price soaring to astronomical levels, climbing a staggering 1600 percent in the month of January. The high-trading volume caused significant losses for hedge funds and other firms that bet the stock price of the struggling company would continue to fall. The market volatility also rattled Wall Street and ultimately caused online trading platform Robinhood to temporarily halt trading.
In the wake of the market volatility, Congress called Robinhood Chief Executive Vlad Tenev to testify. The SEC also launched its own investigation into whether any federal securities regulations were broken and whether additional regulations were needed.
The SEC report largely detailed how and why the meme stock episode occurred, concluding that a rapid increase in trading by individual investors largely fueled the frenzy. In doing so, the agency sought to debunk theories circulating on the Internet that a “short-squeeze” sent the stock price soaring. “Whether driven by a desire to squeeze short-sellers and thus to profit from the resultant rise in price, or by belief in the fundamentals of GameStop, it was the positive sentiment, not the buying-to-cover, that sustained the weeks-long price appreciation of GameStop stock,” the SEC wrote.
While the SEC report does not expressly call for specific regulatory changes, it does make several recommendations. Below are several issues that the agency flagged for further review:
One of the issues most likely to attract further scrutiny is the “game-like” features used by trading apps. In August, the SEC formally requested information and public comment on matters related to the use of digital engagement practices (DEPs) by broker-dealers and investment advisers. “The request will facilitate the commission’s assessment of existing regulations and consideration of whether regulatory action may be needed to further the commission’s mission, including protecting investors,” the SEC said in a press statement.
If you have any questions or if you would like to discuss the matter further, please contact me, Thomas Herndon, Jr., or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.
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